Investment potential in Russia and Eastern Europe
Russia and Eastern Europe have come a long way from food queues and five-year plans. Today, people are more likely to associate the region with oligarchs and football clubs.
But while any cruise down London's Bond Street would confirm that there's a lot of money emerging from the region, foreign investors have been put off by the rumours of shady deals, heavy-handed government interference and poor transparency.
Is the 'Wild East' simply too wild? Or are there investment opportunities in the region?
Let's have a look at the statistics. The MSCI EM Eastern European index is up 17% over one year - the only region to have risen over 12 months. Much of this has been down to the strength of Russia.
The country is still largely influenced by the commodities cycle. Gavin Haynes, investment director at Whitechurch Securities, says: "Due to Russia's wealth of oil and natural gas supplies, investing in this market has been predominantly a way to benefit from rising energy prices.
"The high correlation to energy prices has been demonstrated by the Russian stockmarket's exceptional performance during the rally in energy prices since March 2009. As the price of oil has plummeted since April on renewed fears of a slowdown in the global economy, the RTS (the main Russian index) has also gone into freefall, though it's still ahead over the year."
Sam Vecht, manager of the East European Investment Trust, says that the remainder of Eastern Europe is divided into three main investment regions: Turkey; Kazakhstan and the Ukraine; and central and Eastern Europe.
The latter is more influenced by its convergence with Western Europe, with many of the Eastern European countries now members of the European Union and some still moving towards membership of the euro.
Of course, this is not as attractive a prize as it was five years ago, but many governments in the region believe that there are still trading advantages to be had by closer ties. Turkey dances to its own tune, but has seen strong economic growth. Kazakhstan and the Ukraine are the truly wild frontiers, building their economies on the back of commodities wealth.
While these latter countries may be the wildest of the Wild East, Russia still has its fair share of cowboys.
Mark Gordon-James, senior investment manager at Aberdeen Asset Management, says government interference is a reality for foreign investors. He points out that around half of the RTS benchmark index is controlled by the government, which has stakes in all the major companies such as Gazprom.
"Even outside of these companies, the government has policies regarding oil and gas and mining, and taxation on these companies can be very, very high," he says.
"In other areas such as pharmaceuticals and utilities, the government also wants to have a high degree of influence."
Politics is also a problem. Tim Cockerill, head of research at Ashcourt-Rowan, says: "Russia seems stuck, moving neither forwards nor backwards on the political front. A lot of time and effort is spent in-fighting and this detracts from the need to construct a coherent development agenda."
This is a problem because the country is relying on the emergence of strong consumer demand and the development of better infrastructure to fuel the next stage of its development.
At the moment, the wealth that has built up from oil has tended to go to the government and a few lucky individuals. This is great for the oligarchs and for Chelsea Football Club, but has meant that Russia as a whole has not kept up economically with many of its emerging market peers.
Thomas Orthen, portfolio manager of Allianz RCM BRIC Stars fund, says although the beginning of a consumer economy is emerging, much is still influenced by the price of oil. However, he points out that there are some initiatives to reduce state interference. For example, government ministers are no longer appearing on the board of directors for various companies.
Moreover, Haynes believes that many of these problems are already in the price of the Russian market: "Investors have often cited the high political and corporate governance risks associated with this market as a reason for avoiding it.
However, with share valuations in Russia being much lower relative to other key emerging markets, it appears a lot of these risks are already in the price."
Gordon-Williams says: "It will become more attractive for international investors if there is more security in property ownership and shareholder rights, but investors have to be aware that it is not run like other European countries. It is not democratic."
Until relatively recently, Turkey was everyone's emerging market of choice. Although its accession to the EU seems permanently stalled on the back of various concerns, notably its presence in Cyprus, it has seen strong economic growth.
Elena Shafton, manager of the Jupiter Emerging European Opportunities fund, says that Turkey saw impressive first-quarter growth of 11%, with a leap in lending growth of almost 40%.
However, both Turkish loan growth and its GDP have since slowed. This is partly because of its current account deficit (currently running at high level compared to what it has been historically), but also due to the general malaise in Europe. Yet, Shafton still believes that Turkey has significant potential. She points out that mortgages represent just 5% of GDP and there is a growing population that aspires to consume.
Central Europe had a bad credit crunch as a number of countries found themselves overloaded with foreign-currency denominated debt. This is still a problem, but Vecht says that countries such as Poland, Hungary and the Czech Republic are very competitive economically.
More importantly, he says, companies in this region have the highest growth in earnings per share globally: "This is down to their cheap but highly-skilled workforce, geographic proximity to Europe and low corporate taxation."
He also believes the wild frontiers of Kazakhstan and the Ukraine offer opportunities. Both are emerging from a severe crisis and there is good recovery potential.
Investors willing to risk the Wild East can approach the region through one of the dedicated funds, or opt for a broader emerging markets fund and rely on the manager to make their allocation for them.
Remember, even the adventurers in the Wild West came up with Silicon Valley in the end.
The total money value of all the finished goods and services produced in an economy in one year. It includes all consumer and government consumption, government spending and borrowing, investments and exports (minus imports) and is taken as a guide to a nation’s economic health and financial well being. However, some economists feel GDP is inaccurate because it fails to measure the changes in a nation's standard of living, unpaid labour, savings and inflationary price changes (such as housing booms and stockmarket increases).
Investment trusts are companies that invest money in other companies and whose shares are listed on the London Stock Exchange. As with unit trusts, private investors buying shares in an investment trust are buying into a diversified portfolio of assets (to reduce risk), which is managed by a professional fund manager. Investment trusts differ from unit trusts in two important ways: they are listed on the stockmarket and so are owned by their shareholders and are closed-ended funds with a finite number of shares in issue. This means the share price of investment trusts might not reflect the true value of the assets in the company (known as the net asset value, or NAV) and if the NAV value of a share is £1 and the share price in the market is 90p, the trust is said to be running a discount of 10% to NAV. But this means the investor is paying 90p to gain exposure to £1 of assets. Investment trusts can also borrow money and use this money to buy investments. This is known as gearing and a geared trust is thought to be more of an investment risk than an ungeared one.
Generic, loosely-defined term for markets in a newly industrialised or Third World country that is in the process of moving from a closed economy to an open market economy while building accountability within the system. The World Bank recognises 28 countries as emerging markets, including Argentina, Brazil, China, Czech Republic, Egypt, India, Israel, Morocco, Russia and Venezuela. Because these countries carry additional political, economic and currency risks, investors in emerging markets should accept volatile returns. There is potential to make large profit at the risk of large losses.
A term applied to raw materials (gold, oil) and foodstuffs (wheat, pork bellies) traded on exchanges throughout the world. Since no one really wants to transport all those heavy materials, what is actually traded are commodities futures contracts or options. These are agreements to buy or sell at an agreed price on a specific date. Because commodity prices are volatile, investing in futures is certainly not for the casual investor.
An acronym, which stands for Brazil, Russia, India and China; countries all deemed to be at a similar stage of advanced economic development. The term was coined in 2001 in a report written by Goldman Sachs director Jim O’Neill who speculated that, by 2050, these four economies would be wealthier than most of the current major G7 economic powers.
A standard by which something is measured, usually the performance of investment funds against a specified index, such as the FTSE All-Share. Active fund managers look to outperform their benchmark index. Cautious fund managers aim to hold roughly the same proportion of each constituent as the benchmark, while a manager who deviates away from investing in the benchmark index’s constituents has a better chance of outperforming (or underperforming) the index.
An account opened with a clearing bank (few building societies offer current accounts) that provides the ability to draw cash (usually via a debit card) or cheques from the account. Some pay fairly minimal rates of interest if the account is in credit. Most current accounts insist your monthly income (salary or pension) is paid directly in each month and they offer a number of optional services – such as overdrafts and charge cards – which are negotiable but will incur fees.